Too-big-to-fail proves too-hard-to-solve amid calls to curb banks

European regulators also are seeking ways to structure riskier activities outside of more traditional banking. U.K. Chancellor of the Exchequer George Osborne said for the first time regulators will get the power to break up banks, hardening legislation aimed at making lenders safer. The breakup powers will be added to a bill to be presented to Parliament this week, Osborne said in a speech today. Authorities will be able to split up an institution that doesn’t abide by rules to insulate retail operations from investment-banking activities.

“My message to the banks is clear: If a bank flouts the rules, the regulator and the Treasury will have the power to break it up altogether -- full separation, not just a ring-fence,” Osborne said in Bournemouth, England, according to a text released by his office.

FDIC Latitude

The 848-page Dodd-Frank Act, passed in 2010, sought to reduce the risk of a major bank failure in two ways. It orders the Fed to design higher capital and liquidity requirements and stress test bank portfolios, while also establishing a resolution regime that gives the FDIC wide latitude to wind down a failing institution if bankruptcy isn’t an option.

The impact the collapse of Lehman Brothers Holdings Inc. had on world financial markets and the U.S. economy gives regulators reason to avoid future bankruptcies.

The alternative, using the FDIC’s liquidation authority, has its drawbacks. The law requires the approval of the Treasury secretary to shut down a large bank, bringing politics into the decision. It also would allow any failure of a large bank to be paid for using Treasury funds, with the cost recouped through fees on the industry. Republicans oppose any use of Treasury funds even if repaid.

Friday Nights

“Do you think there is a Treasury secretary ever born or yet to be born that would bring down -- like they do a community bank on a Friday night -- bring down Wells Fargo or Bank of America?” said the ICBA’s Fine. “Hell no. They would do exactly what they did four years ago.”

The resolution regime also could be overwhelmed if several large banks got into trouble at once, said Harvey Rosenblum, research director at the Dallas Fed.

Dodd-Frank’s bank-liquidation rules “could work in one isolated large failure, but anything beyond that would be extremely difficult,” said Rosenblum, who has worked at the Fed since 1970. “We either have to cap their size or force these institutions to break themselves up.”

JPMorgan’s assets rose to $2.36 trillion at the end of 2012, from $1.48 trillion in the third quarter of 2007, according to company filings. Bank of America’s stood at $2.21 trillion compared with $1.58 trillion in the third quarter of 2007. Both New York-based JPMorgan and Charlotte, North Carolina-based Bank of America rescued failing financial companies in the crisis, becoming larger as a result.